That the market’s recent rout was accompanied by rising levels of predicted volatility is hardly surprising. The magnitude of the increase, however, was another story. Short-horizon fundamental risk for the Russell 1000 hit a nine-month low of about 8% early in October but rapidly increased as the market fell, hitting a level of 13.7% as of October 24. The increase—almost six percentage points—left risk more than 70% higher than it was just 14 days earlier, and the scale of this increase is one of the highest we have observed over a similar time frame since at least 1990. In fact, the 5.7-percentage-point increase was higher than it was in 98% of the 14-day periods since 1990.
Since the recent risk nadir on October 4 was relatively low (in the bottom decile of Russell 1000 short-horizon risk levels since 1990), the percentage increase was even more striking. There have been only a handful of 14-day periods in which risk increased more than 70%, and most were either earlier this year or in August-September 2015. Risk had already been rising in 2008 when the bottom fell out of the market, so the risk increase in the subsequent 14 days was lower than it has been recently (5.9 p.p./35%), but of course volatility ultimately rose by almost 20 percentage points, or 109%.
As my colleague Olivier d’Assier pointed out in a blog post earlier this year (see The downside of too little downside risk), “you need to put the absolute size of a market downturn into its proper volatility context.” The recent market downturn, given the relatively low level of initial risk, is certainly one of the big ones.